Use of Investor-level gate provides additional protection during COVID crisis
16 June 2020 - Alternative fund managers are not experiencing the same liquidity crunch as they did during the global financial crisis (GFC) in 2008, and many now have an additional tool to protect investment funds from potential mass redemptions due to the increased prevalence of the investor-level gating mechanism over the past decade.
Comparatively strong performance as well as a more sophisticated investor combined with Central Bank interventions to combat COVID-19 and keep liquidity in the market have to-date negated the need for managers to swiftly raise cash for redemptions. However, the more frequent incorporation of an investor-level gating mechanism in the aftermath of the GFC by open-ended funds in the alternative space has helped to limit a run on liquid investment strategies. Among our clients, its use has risen from obscurity in 2008 to approximately 30% of funds today.
Typical investor-level gating provisions in fund documents cap the amount a single investor can redeem on any given redemption date - typically between 15-25% of an investor’s funds per quarter - allowing for measured withdrawal over a longer period. The investor knows that this mechanism is in place when they invest in the fund and it helps align the longer-term investment horizon of the manager with that of the investor.
Investor-level gating is in contrast to fund-level gating, which may be invoked when funds cannot appropriately liquidate their assets in a timely fashion at a price that is reflective of true value. The imposition of a gate at fund level means that redemption requests are reduced pro-rata to a certain threshold level. An investor will not necessarily have known that a manger would invoke such a fund-level gate when they submit their redemption request and, in times of stress, it may provide an incentive to investors to submit redemption instructions so as to ensure that the investor is able to access their capital and is not left “holding the can” when other investors have submitted their request. In order to avoid a situation where a fund and its remaining investors are left holding only illiquid instruments, in the face of an ensuing flood of redemption requests, managers would have no choice but to invoke a suspension of redemptions to allow for an orderly liquidation of the entire fund. Such a course of action would act to avoid the panicked disposition of assets at potentially depressed prices, however, the suspension of redemptions was often the first step on the road to closure of the fund.
The advantages of an investor-level gate over a fund-level gate are numerous. For example, investors expect the liquidity profile of the portfolio to be aligned with the fund’s redemption terms, which an investor-level gate helps to achieve. Also, investor-level gates permit the fund manager to fund a material percentage of investor redemptions, without compromising the integrity of the portfolio.
Finally, unlike a fund-level gate, an investor-level gate is in place from the outset and the investor understands its tenets on subscription.
By Emer McGuckin, Managing Director, Head of Investor Relations, Citco (Canada) Inc.